What Is Contributed Capital?
The term contributed capital is described as the amount given by the shareholders to the firm for purchasing their stake. The total amount of stock that investors have acquired directly from a corporation is known as contributed capital. The funds and other valuables that stockholders have offered a corporation in return for equity constitute contributed capital.
This contributed capital is entered in the book of account as the term of additional paid-in capital and common stock under the company’s equity category of the balance sheet. Another name for the contributed capital is the paid-in capital and the firms preserve this capital from buyers only when the stake is presented to the buyers directly.
Contributed Capital Formula
There are 2 separate accounts in which the equity portion of the firm’s balance sheet gets split.
There 2 types of accounts are:
Additional Paid-in Capital
It is the term that determines the paid cash submitted by the company’s stakeholders above the fixed value to the firm.
Common Stock
It is the fixed value of filed stakes. The common stock of firms is known to show up on its balance sheet as preferred and common stock.
The formula for Contributed Capital:
Contributed Capital = Common Stock + Additional Paid-in Capital
Example Of Contributed Capital
Now let’s discuss more about contributed capital through an example.
A firm ABC Ltd files 2,000 stocks to the funders at the fixed rate of $15 each. But according to the needs and provisions of the issuance of shares, the funders are liable to pay $200,000 for the bought shares. The shares were completely endorsed, and the funders gave $200,000 to them at the fixed rate of $30,000 (2,000 shares * $15).
Now, for the next share issue, $30,000 will be the fixed rate and will get recorded by the firm under the common stock accounts. Moreover, an extra $170,00 ($200,000 – $30,000) will be stated to the paid-in capital because this value is more than the fixed rate of the stakes. Now, the whole contributed capital will be calculated by adding up both accounts. That becomes, $200,000 ($170,000 + $30,000).
Advantages of Contributed Capital
After learning about contributed capital, its formula, and an example based on it, let’s now head toward understanding what are its advantages.
The advantages are described point-wise below:
1. No set burden to pay
It is to be noted that the amount gathered as the contributed capital cannot raise the fixed payment burden or cost of the firm. So, it is free from any kind of set mandatory payment rules. Such rules exist when the capital is purchased by the firm as a regular interest payment. In this situation, the firm is liable to pay dividends to the stakeholders in a profitable condition. Still, even if there is a profitable condition, it’s not necessary to give the dividend as it’s diverted and deferred to other corporate needs or opportunities if required for the growth of the firm.
2. No Collateral
There is no pledge or statement of collateral asked by the funders for the issuance of equity shares. Such collateral pledges can be requested if a firm gains capital by borrowing them. Apart from that, the assets present with the firm are free, and easily accessible if in the future needed as security for loans. Talking about the newly purchased assets of the firm, they’re raised by the issuance of equity capital. That way, a firm can utilize them to secure its future debts.
3. No Limitations on Usage of Funds
The investors or lenders of money keep their main aim as being able to repay the interest portion and debt on time if the corporation has borrowed the money. That’s why the investor wishes to ensure that the loan proceeds are utilized in a field where they can make the money to fulfill the responsibility of loan repayment on time. The investor then incorporates the economical covenants, which have the authority to restrict the area in which the loan proceeds are being used. But such limitations don’t exist with equity lenders who are dependent on the legal provisions to protect their interest remains.
Disadvantages Of Contributed Capital
Even though there are numerous advantages of contributed capital, there are also certain disadvantages that you must be aware of. The disadvantages will be discussed in this section.
The disadvantages of the contributed capital are as follows:
1. No Assurance of Return
The investors believe that the contributed capital doesn’t hold any assurance in regard to profits dividends, or growth. Their returns are believed to be vague when compared with the returns attained by the holders of debts. Because of this drawback, equity lenders eye for a better return rate from their investment.
2. Ownership Insolvency
The equity investors are the beholders of legal rights when it comes to the directorial board, and also have the permit to take several decisions in high-end corporations. By this right, the firm loses control and ownership.
Difference Between Additional Paid-In Capital and Contributed Capital
Contributed Capital is the entire amount contributed by shareholders when they first buy shares in a firm, and it remains relatively consistent over time unless additional shares are issued. Additional Paid-in Capital, on the other hand, represents the excess amount paid for shares over their nominal value and can fluctuate when new shares are issued or repurchased. Both categories reflect shareholder capital, but in different ways and for distinct reasons in a company’s financial reporting.
Key Takeaways
The firms keep a record of only those getting paid in the capital, which is sold straight to the lenders of the firm. The contributed capital in contrast is recorded only while IPO or any other stake issue which are offered straight to the public. Therefore, in paid-in capital, the traded capital that’s put straight into the market among lenders isn’t saved by the firm. In this case, the firm is neither getting anything, nor is it providing anything, so the paid-in capital stays unchanged.
The term retained earnings are the firm’s end profits that stay undistributed to the stakeholders of the firm in the form of a dividend. It doesn’t become the part of company’s contributed capital because of being limited to the value offered by the lenders for purchasing the company’s equity stock. There isn’t any capital contribution via the investors in retained earnings and therefore it doesn’t add up to become the part of company’s contributed capital.
Conclusion
By now we must have understood that the contributed capital is a type of accounting statement on the company’s balance sheet as a part of paid-in capital and common stock. It reflects the number of funds made by the firm by stock issuance gained by the stakeholders of the firm. There are two ways to buy stocks, either through the exchange for fixed assets or by cash.
One can also get the company stocks in return for the reduction in the firm’s debt. All these elements lead to a rise in stockholders’ equity. Only the capital is sold straight to the lender if the firm is recorded.
FAQ’s
There are two types of accounts in which the equity portions of a company’s balance sheet get split:
- Common stock
- Additional paid-in capital
There are some advantages of contributed capital such as no collateral, no limit on usage of funds, and no set limit to pay. The disadvantages that are generally noticed via contributed capital are ownership insolvency and no assurance on return.
The formula for the contributed capital is,
Common Stock + Additional Paid-in Capital
The money and other valuables that stockholders have provided a corporation in return for equity constitute contributed capital. Whenever a business offers equity stocks at a cost determined by its stockholders, investors contribute capital.
